Legal & Regulatory Change

Since companies began preparing consolidated accounts in the UK in the early 1920s2, the rationale for accounting for investments in other organisations has changed considerably. New forms of business arrangements, ventures and mergers have resulted in the promulgation of fundamental legislation and professional recommendations on the practices associated with group accounting and the disclosure of consolidated statements. 3 Nevertheless, further change is on the way.

While accounting practice in the UK and Ireland has been subject to supranational scrutiny for well over a quarter of a century, the latest attempt at convergence within the single market is the most groundbreaking of them all. In requiring all listed companies within member states to comply with international accounting standards (IASs) from 2005 onwards, the EU has effectively entrusted the IASB4 with responsibility for producing future standards. This paper will focus on the evolution of UK GAAP relating to group accounting and consolidation measures, legislative changes and the effects of convergence and the switch to IFRSs5.

Essentially, attempts will be made to put developments into context, whilst outlining the objectives, disclosure requirements and methods pertaining to the consolidation of subsidiaries and the techniques applied when accounting for investments in associates, joint ventures and other bodies. Primarily, group and consolidated accounts are prepared to report the financial position of a parent undertaking which invests in separate entities. Simplistically, these investments would be recorded as financial assets at cost in the balance sheet of the parent company.

Yet such financial reporting could exclude relevant information relating to these investments and inadequately inform shareholders of the parent's true financial position. 6 Thus, group accounting and consolidation methods have emerged, developing significantly through time. In effect, legislation emanating from the United Kingdom and the European Union has shaped the development of UK GAAP on these matters, though the London Stock Exchange was the first body to require the publication of consolidated accounts in 1939.

The first legal requirement concerning consolidation7 and group accounting in the U. K. was set out in the 1948 Companies Act. 8 Measures pertaining to the disclosure of group accounts were outlined, with a subsidiary relationship defined on the premise of majority equity ownership9. While numerous methods of accounting for significant investments had been formulated and consolidated accounting was already readily employed, the first professional accounting standard, SSAP 110, was not issued until 1971, after the creation of the ASC11 one year earlier.

This standard introduced the basic framework for another method of accounting for investments in other companies, which was first used by Royal Dutch-Shell in 1964. This "intermediate form of accounting"12, which filled the void between the cost-based and full-consolidation approaches, known as the equity method13, though not defined in the standard, was established as a requirement when dealing with associates14 and joint ventures15.

SSAP 1416, (1978), was the first definitive standard issued in relation to group accounts. It largely supported the legal requirements hitherto in force while providing guidance on the mechanics of consolidation. Further legislative developments on the supranational front came to influence UK GAAP. The Fourth Directive of the EEC, issued in 1978, was to impact significantly on consolidation disclosure requirements. Indeed, the Seventh Directive, issued in 1982, would have far greater consequences for group accounting.

Its provisions were transcribed into the legislation of each member state, altering definitions of control17 and of subsidiary undertakings18, introducing further disclosure requirements19 and leading to substantial changes in UK GAAP. Following on the 1985 UK Companies Act and the 1989 Amendment Act, which enacted the Seventh Directive, the ASB produced FRS 220 in 1992 to replace SSAP 14, reflecting changes in the scope of consolidation to encompass subsidiaries arising on the exercise of dominant influence21 under the de facto control principle.

FRS 522 also improved accounting measures for quasi-subsidiaries23, while FRS 624 (which replaced SSAP 2325) set out guidelines for acquisition and merger accounting. FRS 726, which was released in 1994, also impacted on acquisition accounting by setting down principles for determining the fair values of assets and liabilities and therefore goodwill27 when accounting for a business combination. Then, in 1997, the ASB issued FRS 928, superseding SSAP 1, to improve accounting for associates, joint ventures and joint arrangements that are not entities (JANEs).

Later that year FRS 1029 was published, requiring the capitalisation of goodwill on acquisition and its amortisation over its useful economic life30 through the profit and loss account and providing scope for impairment reviews. 31 Now, in 2004, companies and auditing groups in the UK and Ireland are coming to terms with the latest EU regulation, which requires all companies within member states quoted on regulated markets to comply with IASs and IFRSs by 2005. Though, before examining the effects of this change, it is worthwhile to analyse the various methods of consolidation and how they have evolved through time.